How to strategically filter your target list for buying a business?
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This is the sixth article in our “What to Consider Before Buying a Business” series. In earlier articles, we established the overview of the strategic steps for acquisition (Part 1), analyzed markets to identify the best one (Part 2), discussed the buy vs. build decision (Part 3), outlined how to define target criteria (Part 4), and explored building a target pipeline (Part 5). Now, we will guide you on how to filter the target list, a crucial step in narrowing down potential acquisition opportunities to those most aligned with your long-term vision and strategy.
This strategic filter of the target list is the first major inspection of a property you’re considering buying. Just as you wouldn’t invest in a house with structural issues, you want to ensure the businesses on your list are solid, defensible, and scalable. With this process, you’ll filter out unsuitable candidates and focus on those that match your goals for growth and sustainability.
Revisit your strategic foundations
Before diving into how you should filter your target list, revisit the foundational work we’ve already discussed in this series. By aligning with your previously defined target criteria and overall strategy, you ensure the businesses on your list match your long-term goals.
Steps to Take:
- Refer to your defined target criteria from Part 4, including financial capacity, industry focus, and geographic preferences.
- Review insights from your market analysis in Part 2 to understand the broader dynamics affecting each business.
This alignment ensures that your filtering process remains grounded in your original vision, helping you stay strategic and focused.
Assess market position and defensibility
Once you’ve revisited your strategy, it’s time to evaluate how each business stacks up in its market. A strong market position is critical, but equally important is whether the business can defend its position against competitors and market disruptions.
Key questions to ask:
- How strong is the business’s position in the market? Examine market share, customer loyalty, and competitive advantages such as unique value propositions or proprietary technology.
- Does the business have the ability to defend its position? Look for barriers to entry, loyal customer bases, or intellectual property that prevents competitors from easily entering the space.
- What are the barriers to entry? Businesses in markets with high entry barriers, like limited permits or strong regulatory protections, tend to have a more defensible position.
Example (Real Estate): In urban areas with strict zoning laws, rental property businesses may enjoy a stronger defensible position. Fewer new entrants mean less competition, and long-term tenants add to the stability of the business.
Identify red flags early
During filtering the target list, it’s critical to spot potential risks and red flags that could derail an acquisition. Some issues may disqualify a business outright, while others might warrant closer investigation in later stages.
Common red flags:
- Legal issues: Look for ongoing litigation, unresolved intellectual property disputes, or compliance violations.
- Regulatory risks: In heavily regulated industries, non-compliance can lead to fines or operational shutdowns.
- Financial discrepancies: Inconsistent or incomplete financial statements can indicate deeper financial instability.
- Unclear business models: Businesses without a clear or scalable model may struggle to sustain growth.
Example (Tech): A startup with an innovative product but inconsistent revenue reporting and no defensible intellectual property is a high-risk investment.
Identifying red flags early allows you to avoid wasting time on businesses that don’t meet your expectations or require extensive fixes.
Evaluate growth potential and market expansion
Once you’ve weeded out businesses with significant risks, the next step is to analyze their growth potential to filter the target list. A viable business must not only perform well today but also have clear opportunities for expansion and adaptability to changing markets.
Key questions to ask:
- Is there room for market expansion? Look for opportunities to expand into new geographies, target different customer segments, or add new product lines.
- What are the industry’s growth rates? Industries with steady or high growth rates provide better long-term opportunities than those in decline.
- Does the business have the infrastructure to support growth? Evaluate whether the company has the operational capacity, financial stability, and human resources needed to scale.
Example (Restaurants): A small restaurant chain with strong customer loyalty and multiple locations in one city could expand into nearby regions. However, without a scalable supply chain, growth may be constrained.
Benchmark performance against competitors
In the next step of the filtering of the list, competitive benchmarking allows you to see how the business compares with others in the same industry. This step ensures you understand the business’s strengths and weaknesses relative to its peers.
Key questions to ask:
- Who are the direct and indirect competitors? Identify competitors in the same market and assess how they differ in terms of pricing, product quality, and customer satisfaction.
- How does the business measure up to competitors’ key purchasing criteria? Evaluate factors such as product quality, pricing, customer service, and innovation to see where the business has a competitive edge.
Example (Real Estate): Compare rental property management companies based on tenant satisfaction, maintenance quality, and rental pricing. A company offering better service or competitive pricing may hold a stronger market position.
Ensure alignment with your long-term strategy
After filtering the target list based on defensibility, growth potential, and competitive benchmarking, take a step back to confirm alignment with your overarching goals.
Key questions to ask:
- Does the business align with your vision for growth? Assess whether its market position, financial health, and operational fit support your long-term strategy.
- Can it adapt to future trends or disruptions? Look for businesses with the agility to navigate technological advancements, shifting customer preferences, or market fluctuations.
Example (Tech): A SaaS company with a scalable product and strong recurring revenue aligns well with growth-oriented strategies, especially if it can adapt to rapid changes in technology.
Conclusion: strategic filtering of the target list
Strategic filter of the target list is a crucial step in narrowing down potential acquisition opportunities to those most aligned with your vision and goals. By revisiting your foundational strategies, assessing market position and growth potential, and identifying red flags early, you’ll ensure your efforts are focused on viable and sustainable businesses.
This article builds on the foundational concepts we discussed in earlier parts of the series, with published parts being:
- In Part 1, we established strategic foundations for business acquisition.
- In Part 2, we explored how to select the best markets.
- In Part 3, we evaluated whether to build or buy a business.
- In Part 4, we defined target criteria to guide your acquisition strategy.
- In Part 5, we guided you on ways to build a strong target pipeline.
- In Part 6, we showed you how to do an initial strategic filtering by doing commercial due diligence.
- In Part 7, we gave you keys to do a financial due diligence/ financial evaluation on your acquisition targets.
With your filtered target list in place, you’re now ready to move forward into deeper due diligence and negotiation. In the next article, we’ll dive into these crucial steps to ensure a successful acquisition. Stay tuned as we guide you closer to achieving your entrepreneurial goals!